The New Normal

Will the Financial Services Industry Ring the Bell for Law’s New Normal?

In 1995, when Microsoft rolled out the Windows operating system to great fanfare, Microsoft’s graphical user interface and other features appeared to many Apple aficionados to be so derivative of their preferred product that they made a bumper sticker:

Windows 95 = Mac 88

I was a newly minted general counsel in Silicon Valley at the time, and like most of my peers found that clients approached life a lot differently than the law firm and law school world we had come from. And so we set about trying to synthesize those views and became practitioners of, what, for want of better term, we can call “New Normal” law—focused on outcomes, innovation and technological substitution, quality rather than cost, risk management rather than risk aversion. It was a GC-led approach rather than a firm-led approach, emphasizing the concrete over the abstract. And it seemed to work far better both at realizing opportunity and managing risk than the traditional style we had come from. But the firms didn’t especially like it because it was more demanding and slightly less profitable. In fact, by 1997, many of the law firms in the market started “firing” their more demanding public company clients to focus on start-ups because the start-ups were less sophisticated and potentially more remunerative (paying partially in equity).

But that wasn’t the only trend. The financial services industry—which represented perhaps $25 billion out of the high-end law firm market of $80 billion—was driving the strategy of most law firms, even as it was garnering a historically anomalous share of profits across industries. It was as if the law firms had all hired the same consultant and decided to be Porsche, a monoline high-end player, and not Toyota, a multiline, high-quality player including Lexus, but also Camry and Prius.

Why did the firms pursue the financial industry-first strategy? Because the top financial companies seemed to be willing to pay more for legal services. I’m not an industry expert, but as a student of markets, let me suggest some reasons why the financial services industry has been less cost sensitive on legal services:

• They deal in big dollars and big margins, so they are generally more willing to pay for premium services, including law.

• They often pass on legal costs to the banks’ clients.

• Their work is often more complex, so they will select lawyers with the greatest capacity to handle complexity.

• Sometimes there is a big difference in outcomes (value) based on a small difference in inputs (quality).

• They deal in regulated Intangibles like derivatives (i.e., to an extent unimaginable to a company that manufactures bricks, their product is defined by law), so lawyers represent a larger percentage of their “cost of goods sold.”

• They were in rapid-growth mode with globalization and securitization, so the laws of supply and demand drove prices up.

• They value brands, and so they choose well-known firms, as much for internal validation as external.

• They had institutional relationships with law firms, getting deal flow influenced by—and frequently coming from or going back to—those firms, so they understood their interests to be aligned.

None of those factors will disappear in 2012. But as my old boss, Walter Mondale, once said: We can’t live in a country where the only jobs are taking in each other’s dry cleaning and repairing Japanese cars. Or as an economist might put it: The financial industry can not materially out-perform the real economy over the long run, nor can the law firms that support it. Or even more specifically :Both trading desks can’t book a profit on the same proprietary trade forever. So now the financial industry and the real economy are in mutually re-enforcing tough times, and we’re seeing retrenchment which will impact legal spending, with new cutbacks announced daily.

Last week, I met with three large financial industry clients. All are New Normalizing. And as they see that their peers are doing much the same thing, they will do it more aggressively, and since they’ve waited a while, and the playbook is quite apparent, the effect will feel quite dramatic, with many law firms seeing drops of 20 percent or more in spending from these clients.

What are the implications for law firms? For the 15 or so elite New York- and London-based firms that have traditionally represented the financial industry, life has been good, and the philosophy of “if it ain’t broke, don’t fix it” perhaps made sense. Most of these firms will end up on top regardless, although many firms may find that not fixing things becomes a habit that’s hard to shake. (I also recall from the same mid-‘90’s period in Silicon Valley that Apple was on the ropes, everyone thought Microsoft would be dominant forever, and the CEO of Sun said they might buy Apple for the buildings. See The Innovator’s Dilemma.)

For the balance of the Am Law 85, the situation is much trickier. For the past decade, they have oriented their practices to the very high end, winnowing partners, paying top dollar for laterals, expanding in higher-cost markets. That strategy has now run its course, and the Am Law 85 will have to find a new one. Like Toyota, they’ll have to figure out how to be a profitable, high-quality, efficient producer in different market segments, not just Lexus. Of course, part of Toyota’s secret is its tight coupling with its suppliers and its Lean philosophy, which allow it and its business partners to learn together, and this is an approach firms would do well to embrace.

When I first wrote a few years ago that the financial meltdown signaled the beginning of the transformation of the legal industry, some folks told me I was crazy, and that once markets picked up, things would “get back to normal.” But let me suggest that we already know what the New Normal will look like:

Wall Street Legal Market 2012 = Silicon Valley Legal Market 1995

Paul Lippe is the founder and CEO of the Legal OnRamp, a Silicon Valley-based initiative founded in cooperation with Cisco Systems to improve legal quality and efficiency through collaboration, automation and process re-engineering. Lippe formerly was an executive at the electronic design automation company Synopsys and later was CEO of Stanford SKOLAR, a medical digital library and e-learning company sponsored by Stanford Medical School.

Editor’s note:The New Normal is an ongoing discussion between Paul Lippe, the CEO of Legal OnRamp, and Patrick Lamb, founding member of Valorem Law Group. Paul and Pat spend a lot of time thinking, writing and speaking about the changes occurring in the delivery of legal services. We hope you will join their discussions.